RISK ASSESSMENT

Growth to remain firm in 2018, but below potential

The Moldovan economy was hit by a banking scandal in 2015 involving the embezzlement of over USD one billion (15% of GDP), the collapse of three major banks and a considerable downturn in economic activity. Since 2016, the consolidation of the financial sector, as well as the positive shock of external demand mainly from the European Union and Turkey, helped restore growth, which should remain satisfactory in 2018. Private consumption, which accounts for 86% of GDP, should increase, benefiting from low unemployment, higher real wages and disposable household income. This is because remittances from Moldovan workers abroad, concentrated in Russia, are likely to continue to benefit from the Russian economic recovery (remittances up 9.5% in the first six months of 2017). The country depends on these flows, which represented 20% of GDP in 2016. Inflation is expected to continue to fall in 2018, but this will probably be accompanied by a tighter monetary policy. The manufacturing industries are struggling to expand and the retail and agrifood sectors are the main drivers of activity. Meanwhile, Moldova depends on the primary sector (14% of GDP and 33% of jobs in 2016). Weather conditions were favourable for the 2016-2017 harvest. Accordingly, agricultural production climbed 103% during the first 9 months of 2017 compared with 2016. Foreign investment, which fell in 2015, is picking up again gradually though is hampered by political instability.

Slow improvement in the public accounts

The IMF’s Extended Credit Facility Mechanism (ECFM) and the Extended Credit Facility (ECF) are delivering USD 178 million (3% of GDP) over the period 2016-2019 and are mainly intended for restructuring the financial sector and boosting public revenues. It is in this context that numerous reforms have been implemented to improve the supervision of banks and their activities, as the government is keen to comply with Basel III agreements. However, the ratio of non-performing loans is still high, at almost 17%. The IMF’s requirements have led to a policy of fiscal consolidation which will require strong increases in tax receipts (especially VAT) and diversification of income sources. Public investment spending will also rise, but more modestly.

The current account deficit is expected to remain fairly high in 2018, because of the huge trade deficit (29% of GDP in 2016) despite remittances from expatriate workers. Demand from European countries is expected to continue to stimulate exports following the entry into force of the free-trade agreement with the EU in 2016. Moldova’s main trading partners are its neighbours (Ukraine, Rumania), but exports to Western European countries are growing fast (+20% to Germany, +12% to Italy in 2017). Exports mainly comprise agricultural products, electric cables and clothing ensembles. Moldova will benefit from the drop in import prices following the 14.5% appreciation in the lev against the dollar during the first ten months of 2017. However, this will not be enough to offset the rise in commodity prices, especially those of oil and gas imported from Russia. To finance its current account deficit, the country makes use of concessional loans from the IMF and the World Bank. Foreign exchange reserves remain at a comfortable level of USD 2.5 billion or almost 7 months of imports.

Tensions in the run-up to the 2018 parliamentary elections

The 2015 banking scandal led to a loss of confidence in the political class. The first presidential election conducted by universal suffrage took place in November 2016 and resulted in a victory for Igor Dodon, from the Party of Socialists of the Republic of Moldova (PRSM), elected for a four-year term. The Head of State, from a pro-Russian coalition, has to cohabit with a majority pro-European government, led by Pavel Filip (Democratic Party). So, the balance will remain fragile and tensions will remain high until the next parliamentary elections scheduled for November 2018. They will allow the 101 seats in the single-chamber parliament to be filled and the favourite in the polls is the PRSM. However, there is a possibility of foreign policy leaning towards Russia. This will be the first election following the entry into force of a divisive electoral code, which was met with protests. There has been a shift from a proportional system to a mixed system within which MPs will be elected at both local and national level. The polarisation of political life into two camps - pro-Russian and pro-European - is behind the tensions in the run-up to the elections. So, in response to a government request, the Constitutional Court decided to temporarily suspend the president for rejecting all government nominations for the vacant post of Minister of Defence.

Moldova is in the grip of separatist ambitions involving the eastern Russian-speaking region of Transnistria, which enjoys autonomous status and which unilaterally declared independence under the name of the Dniester Moldovan Republic in 1992. A referendum (not recognised by the central government) took place in 2006 and the de facto leader of the region issued a decree in 2016 to join Russia.